ECONOMICS

Principles & Policy

William J. Baumol

& Alan S. Blinder

PowerPoint slides prepared by:

Andreea Chiritescu

Eastern Illinois University

Modified by Hui He, UHM

Economics: Principles & Policy

11e Baumol & Blinder

© 2009 Cengage

Chapter 1

What is Economics?

Why does public discussion of economic policy so often show the abysmal ignorance of the

participants? Why do I so often want to cry at what public figures, the press, and television

commentators say about economic affairs?ROBERT M. SOLOW

Outline

• Give you some idea of the issuesissues that economic analysis help to clarify and the solutionssolutions that economic principles suggest

• Introduce the toolstools that economists use

Ideas for Beyond the Final Exam

1. How much does it really cost?– Opportunity cost

• Value of next bestnext best alternative forgone (first best is your choice)

• Example: what is the cost to go to college? direct cost = TFRB, indirect cost=four year forgone wage

4

Ideas for Beyond the Final Exam

2. Attempts to repeal laws of supply & demand - Market strikes back

• Price ceilings (NYC rent control creates shortage and lack of maintenance of apartments)

• Price floors (price support of agricultural products leads to surplus)

Ideas for Beyond the Final Exam

3. Surprising principle: comparative advantage (Chapter 17)

• Law of comparative advantage: Even China can produce everything more cheaply, two nations can still gain from trade by specializing in relativelyrelatively cheaper items

Ideas for Beyond the Final Exam

4. Trade = win-win situation• Voluntary trade – all parties gain

5. Government policies - limit economic fluctuations - but don’t always succeed (Chapter 11-13)

– Fiscal policy: tax and Gov. spending

– Monetary policy: money supply and interest rates

7

Ideas for Beyond the Final Exam

6. Short-run trade-offtrade-off between inflation & unemployment (Chapter 16)

– Low unemployment - high inflation

– High unemployment – low inflation

7.7. Productivity growthProductivity growth is (almost) everything in long run (Chapter 7)

– Small increase in labor productivity – higher living standard

– Slowdown in labor productivity – lower living standard 8

Inside the Economist’s Tool Kit

• Economics as a discipline uses– Mathematical reasoning

– Historical study

– Statistics

• Need for abstraction– Ignore many details

– Focus: most important elements

9

Detailed Road Map of Los Angeles

Map 1

10

Major Los Angeles Arteries and Freeways

Map 2

11

Inside the Economist’s Tool Kit

• Abstraction, simplification– Unimportant details

– Necessary• Understand complex economy

• Degree of abstraction– Objective of analysis

12

Greater Los Angeles Freeways

Map 3

13

Inside the Economist’s Tool Kit

• Economic theory– Deliberate simplification of reality

– Explain how relationships work (mechanismmechanism)

– Answer counterfactual experiment

• Statistical correlation– Variables - go up or down together

– Need not imply causation

14

Inside the Economist’s Tool Kit

• Economic model– Simplification - aspect of the real

economy

– Expressed• Equations• Graphs• Words

• Disagreements– Imperfect information

– Value judgments15

APPENDIX

Using graphs: a review• Economic graphs

– Large quantity of data - quickly

– Facilitate data interpretation & analysis

– At a glance• Important statistical relationships

• Variable– Measure: number

– Analysis

16

APPENDIX

Using graphs: a review• Two-variable diagrams

• Horizontal axis• Vertical axis• Origin

– Abstract

– Focus• Two variables of primary interest

17

Hypothetical demand curve for natural gas: St. Louis

Figure 1

18

Quantity

20 40 60 80 100 120 1400

Pric

e

1

2

3

4

5

6

b

Q

P

(a)

Quantity

20 40 60 80 100 120 1400

Pric

e1

2

3

4

5

6

Q

P

(b)

a

D

a

b

Quantities of natural gas demanded at various prices

Table 1

19

Price (per thousand cubic feet) $2 $3 $4 $5 $6

Quantity demanded (billionsof cubic feet per year) 120 80 56 38 20

APPENDIX

Using graphs: a review• Slope of straight line

– Ratio: vertical change “rise”

– To: horizontal change “run”

• Negative slope– One variable falls, other rises

• Positive slope– Both variables rise

20

Different types of slope of a straight-line graph

Figure 2

21

(a)

Y

X0

(b)

Y

X0

(c)

Y

X0 (d)

Y

X0

Negative slope

Positive slope

Zero slopeInfinite

slope

APPENDIX

Using graphs: a review• Zero slope

– Y value doesn’t change

• Infinite slope– X value doesn’t change

• Slope of straight line– Same numerical value

22

How to measure slope

Figure 3

23

(a)

Y

X0

(b)

Slope = 1/10

133

89

A

C

B

Y

X0

Slope = 3/10

133

8

11

A

C

B

APPENDIX

Using graphs: a review• Slope of curved line

– Different numerical value

– At one point• Slope of tangent (straight line)

24

Behavior of slopes in curved graphs

Figure 4

25

(a)

Y

X0

(b)

Y

X0

(c)

Y

X0 (d)

Y

X0

Negative slope Positive slope

Positive

slope

Negative

slope

Negative

slope Positive

slope

How to measure slope at a point on a curved graph

Figure 5

26

E

X1 2 3 4 5 6 70 8 9 10

Y

1

2

3

4

5

6

7

8 r

rT

R

G

M

t

tB

F

A

C

D

APPENDIX

Using graphs: a review• Y-intercept• X-intercept• Ray through origin

– Y-intercept = zero

• 45° lines– Rays through origin

– Slope = 1

– Angle = 45°

– X=Y 27

Rays through the origin

Figure 6

28

X1 2 30 4 5

Y

1

2

3

4

5

A

B

K

E

D

CSlope = +1

Slope = +1/2

Slope = +2

APPENDIX

Using graphs: a review• Contour map (topographical map)

– Three pieces of data• Latitude• Longitude• Altitude

29

A geographic contour map

Figure 7

30

APPENDIX

Using graphs: a review• Production indifference map

– Axes - quantities of two inputs

– Curve - given quantity of output• Points on curve

– Different quantities of two inputs– Just enough – produce given output

31

An economic contour map

Figure 8

32

Labor hours per day

10 20 30 40 50 60 700 80X

Y

10

20

30

40

50

60

70

80

Yar

ds o

f cl

oth

per

day

Z = 10

Z = 20

Z = 40

Z = 30

A

B